£100,000 income, £400 tax bill

How would you like a tax-free retirement? It's perfectly feasible - if you
follow these tips.

You don't have to employ Jimmy Carr's accountant to cut your tax rate to low single figures. In fact by making the most of all the reliefs and allowances available to them through their lives, wealthy pensioners can draw a six-figure income and pay a three-figure tax bill.

A wealthy retired person could receive income in excess of £100,000 and pay tax of less than £400 a year – an effective tax rate of less than 0.4pc – by clever use of all the breaks on offer.

Regardless of how big a nest egg you are building up, people of all income brackets can slash their tax bill by spreading their assets across a range of savings vehicles. Pensions, Isas, open-ended investment companies (Oeics) and life insurance bonds all offer different breaks. Use them together in the right way and you can almost eradicate your tax bill altogether, as our theoretical but entirely feasible example shows.

Andy Zanelli, head of technical consultancy at Axa Wealth, said: "Most people are fixated on driving a really good return on their investments. But making the best possible use of all the allowances and exemptions that are available will often make as great a difference to the amount of your money you get to keep."

The tax advantages of pensions are well known. Pension contributions are tax-free, and, while the income is taxable, many people pay a lower rate of tax in retirement than when they are working. A quarter of the fund can be taken as a tax-free lump sum.

Onshore bonds allow higher-rate taxpayers to defer tax on their investments until a time in the future when they might be paying income tax at a lower rate, and are usually used after Isa limits have been exhausted. Withdrawals of original capital of up to 5pc for each year the bond has been held are allowed.

Some investment bonds carry high charges and Jason Butler, principal at Bloomsbury Financial Planning, warns against letting the tax tail wag the investment dog. Mr Butler said: "There have been many examples of people selling life bonds with no regard to the investments held within them, which has not been in investors' interests. You have to let the investments lead the tax planning and not the other way round."

One valuable yet underused tax perk is the £10,900 a year capital gains tax exemption, which can be exploited by investing in funds that target growth stocks rather than companies that pay dividends. Opt for unit trusts or Oeics that invest in dividend-paying blue chips and you will end up pushing up your tax bill. By investing in growth stocks that focus on increasing the company's share price rather than paying dividends, you can make the most of your CGT allowance.

An Oeic returning £10,000 of income will increase an investor's income taxable income by that amount, whereas an identical increase in asset value will incur no tax at all because it falls below the £10,900 CGT allowance. Advisers recommend making sure your portfolio is properly diversified, however.

For couples where one partner holds the majority of the assets, it can make sense to give them to the other partner so that both sets of allowances and exemptions can be used.

But Mr Zanelli said: "You need to be using your wrappers [such as Isas] and allowances in the right way throughout your savings lifetime. Get your ducks in a row now and you will have the flexibility to manage the way you pay tax when you come to retire."

The detail: how it works

An individual has a portfolio of £1.5m. By building up savings of £500,000 in a self-invested personal pension (Sipp), £500,000 in an onshore bond and another £500,000 in both Isas and Oeics, he or she could receive income of £101,703 a year and pay £378 in tax.

For the purposes of this example, the life insurance bond is assumed to be from an original investment of £250,000 made from an inheritance 10 years ago, which has now grown to £500,000. The Oeic is assumed to have built up by saving £12,000 a year, growing at an average 6.5pc a year for 20 years. The Oeic is invested in low-yielding growth funds producing dividends of 1pc a year, giving £5,000 income net or £5,555 gross, from which £555 in tax has already been deducted at source.

Under our example the individual crystallises £50,000 of the Sipp pot, giving a 25pc tax-free lump sum of £12,500, plus £2,475 a year from income drawdown, assuming age 65 and a gilt yield of 4pc. We also assume he receives basic state pension of £5,728.

He also withdraws £26,000 from the bond by surrendering 13 of the 250 segments under which the product has been written. The chargeable gain of £13,000 over 10 years does not create an income tax liability.

He then also draws £25,000 from the Oeic, with a capital gain of £13,000, of which £2,100 is liable for capital gains tax after the annual £10,900 exemption is taken into account. Finally, he withdraws £25,000 from the Isa, on which no tax is payable at all.

This individual's income tax liability falls below his personal allowance and his capital gains tax bill is just £378, giving him a total tax rate of barely 0.4pc on an income of £101,703.